Week 7.pptx - Finance 1 Equities and derivatives Roadmap...

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Finance 1 Equities and derivatives
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Roadmap Week 2: Financial calculus Week 3: Investment preferences Week 4: Risk, return and diversification Week 5: Portfolio choice Week 6: Asset prices and market efficiency Week 7: Money markets and bond markets Week 8: Equities and derivatives Week 9: Revision Week 10: Class test
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Equity markets Institutions and vocabulary, dividend discount model, comparables Derivatives Institutions, margin accounts, futures, options Goals for today
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Equities Equity / stock contract: Promises the owner Share of future dividends Voting rights as a shareholder Equity holders have limited liability Primary vs. secondary markets IPO Trading on stock exchange
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Major stock exchanges NYSE: Market cap $19trn, monthly volume $1.5trn, physical trading (“open outcry”) NASDAQ: Market cap $6trn, monthly volume $1.1trn, electronic trading LSE: Market cap $6trn, monthly volume $1.65trn, electronic trading Japan, Shanghai, Hong Kong, Euronext…
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Mechanics and costs of trading Individual and institutional investors instruct brokers to buy / sell on their behalf Direct costs of trading: Broker commissions / fees Range from 20 to more than 200 basis points, depending on market Indirect costs: Brokers quote two prices you buy at the “ask” (or “offer”) price you sell at the “bid” price (< ask) the difference is the spread , profit for market makers, captures the cost of a “round trip”
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Short sales Selling without owning Borrow asset from broker, instruct her to sell it After specified period, repurchase security and return to broker Contrast with “long” position (buying outright) Return on short position = - [Return on owning asset] Shorting is a bet on low / negative returns Short seller must pay dividends accruing during the borrowing period
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Dividend discount model PV of a stock that pays dividend in t periods’ time: Open questions: How to forecast an infinite series of dividends? What is the appropriate (risk-adjusted) discount rate k ?
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Discount rates for stock valuation Discount rate Opportunity cost Expected rate of return on an equivalent investment Trick : Use asset pricing theory to find k CAPM gives expected return Set k = for pricing stock j
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Gordon model How to forecast infinite series?
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